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Is the Coal Market Catching Fire?

March 28, 2014

In the past several months, the coal market has showed signs of recovery mainly due to harsh winter conditions in the U.S. Coal companies such as CONSOL Energy (NYSE:CNX) and Arch Coal (NYSE: ACI) have benefited from these developments as these companies’ shares rallied in recent months. But is the coal market heating up enough to augment these companies’ revenue and improve their profit margin in 2014? Let’s take a closer look at the recent developments in the coal market.

Boost in demand from the weather

The colder than normal winter has pressured up the price of natural gas to a high level compared to last year’s winter prices. The rise in natural gas prices, mainly for heating purposes, has resulted in utility companies shifting back from natural gas to coal. On a yearly scale, the U.S Energy Information Administration expects the U.S coal demand will increase by 4.6% to 966 million short tons. The rise in demand for coal will also pressure up coal production. The EIA estimates coal production will rally by 3.2% during 2014 to 1,028 MMst. These changes are likely to reflect a higher level of production for leading coal companies such asCONSOL Energy and Arch Coal especially in the first quarter earnings reports. According Arch Coal’s annual guidance for 2014, the company still expects a 2% decline in its coal sales (in tons) from 139.6 million tons in 2013 to an average of 137 million tons. The improved coal market conditions could result in a higher than expected coal production. Moreover, if the price of coal rises further, this could improve its operating margin and cut down the company’s losses.

CONSOL Energy has expanded its proved natural gas reserves by 44% to a record high of 5.7 trillion cubic feet equivalents during last year. The rise in natural gas operations came on the expense of the company’s coal projects. In 2014 , CONSOL Energy expects its coal production to decline by 44% (year over year) to 31.1 million tons mainly due to the five West Virginia Longwall coal mines it sold during the last quarter of 2013. Therefore, the company is likely to benefit not only from the rise in demand for coal but also from the rally in natural gas prices.

Despite the recovery of coal in the first quarter of 2014, the coal market isn’t likely to improve on a yearly scale. Further, coal companies won’t increase their revenue or widen their profit margins for the following reasons:

Higher demand doesn’t translate to higher prices: Back in 2013 the demand for coal rose, but this rally didn’t pull up the price of coal — it fell by 1.2% to $2.35 MMBtu. Moreover, in 2014, the price of coal is expected to remain low at $2.36 MMBtu. As a result, coal margins aren’t likely to improve even if the demand for coal rises;

Lower exports: the EIA estimates coal exports will decline to 103 MMst in 2014 — a 13% drop, year over year . Further, coal exports are still a small portion of the coal market: They represent 13% of total demand for coal in the U.S in 2013. Some analysts suspect the U.S exports to Europe, which account for 50% of total exports, may rise due to the recent turmoil in Ukraine. Even if exports rally, the ongoing decline in coal trade prices is likely to reduce the margins on coal sales. This trend could eventually make it less profitable to export coal;

Environmental costs: The U.S Environmental Protection Agency has made it very expensive to operate coal fired plants by enforcing its Mercury and Air Toxics Standards. This is why utility companies are slowly closing coal fired plants and don’t open new ones. Case in point, back in 2013, FirstEnergy closed two of its coal fired plants as they incurred $280 million in fines the company had to pay.

Takeaway

The coal market heated up in the past several months, but this rally won’t be enough to improve coal producers’ operating margins or revenues on a yearly scale. Even if exports start to pick up, they won’t be enough to keep the coal market heated. On the other hand, if the price of natural gas remains elevated and higher than its normal levels, this could pressure up coal prices. Higher coal prices could be enough to improve coal companies operating margins and increase sales.

Disclaimer:The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.